Observations focused on the problems of an underdeveloped country, Venezuela, with some serendipity about the world (orchids, techs, science, investments, politics) at large. A famous Venezuelan, Juan Pablo Perez Alfonzo, referred to oil as the devil's excrement. For countries, easy wealth appears indeed to be the sure path to failure. Venezuela might be a clear example of that.

Archive for March 7th, 2012

During the last few weeks, Venezuela and PDVSA bonds have rallied sharply, as investors see increased probability of not only a possible political change in the country, but more importantly, change in the way Venezuela’s public finances are managed.

The rally has been stupendous as seen in the graph below, which shows the price of PDVSA’s 2022 bond, which carries a 12.75% coupon and which was issued in February of 2011:

The bond above has shown three distinct periods over the last year which I have noted with red boxes. First, there was rally last June, when President Chavez became sick. This rally was stopped (second red box) from August to November as the European crisis unfolded. Then, the last and powerful leg this year is shown in the third box and it began in January, as optimism all around the world first drove markets up, which was followed by a move up upon the successful opposition primaries, which received another powerful push up with the news that Chavez’s cancer had returned and the President had to be operated.

Chavismo has called the rally perverse. But in the end, the rally is a bet not on President Chavez’ demise, but the fact that if Chavez played a smaller role in the future of Venezuelan politics, the role of Minister of Finance and Planning Jorge Giordani would also be diminished. Because Giordani was, after all, ranked as the worst economic Minister of Latin America recently.

And ever since Giordani took charge of of Planning and ltaer Finance, Venezuela’s financing costs had been increasing and refused to drop. This can be seen in the next graph, where I show the Global 2027 bond from the year 2000 to last week. As you can see this bond has been at much higher prices (lower yields) than it is today during Chavez’ tenure, despite the fact that oil prices are near an all time high today.

From 2003 to 2007, this bond rose sharply, as oil prices increased. Venezuela had a relatively small debt and new issues were coming to market slowly and in a manner fairly well understood by the markets. Then came the financial crisis of 2008-2009, oil prices dropped and debt prices went down. During this time, Venezuela and PDVSA began offering ever increasing amounts of debt to sustain the exchange rate at an artificially low level. Even worse, the attitude towards the same investors that buy this debt has been unfriendly, surprising the market and issuing large size bonds that flooded the market with paper.

Thus, after the yield in the Global 2027, shown below, hit near 20% during the financial crisis, it had been unable to drop below the ~13% level until last summer.

The rally has been impressive. The PDVSA 2022, issued in February 2011, which traded at 75% in its first day, closed yesterday at 100%. That is a 33% return on capital to those that bought the first day, to which you have to add 17% return in interest, or 50% in little over twelve months.

The question everyone asks, is whether this can continue.

Well, as long as there is the possibility of change in the way the country is managed, the rally can certainly go on. While yields may not go down to the levels of 2006-2007, because the country’s debt has increased dramatically over these years, oil prices are higher and Venezuela could be in better shape than other countries yielding 2% to 3% below Venezuela’s yield. It is, in the end, all relative.

But the ride is likely to be bumpy, as the sell-off yesterday shows, after the violence on Sunday during Capriles’ rally. Investors can scare easily, even if the potential returns can be very attractive. But investors like the yield and this provides some cushion in this bumpy ride.

As usual with investments, it is when to sell that is the toughest to decide.